Time limitation: Introduction to concept of year of discovery for foreign assets

In earlier articles on the matter of 'foreign assets' of Pakistani citizens, which have been written for Business Recorder, this writer discussed the concept of 'time limitation' with reference to concealed income and assets created out of such concealed income. In summary, it was noted that assets identified after the lapse of time limitation prescribed under the Income Tax laws cannot be brought within the ambit of taxation laws. This is an important, sensitive and relevant subject with respect of implementation of tax laws and documentation of economy.
It is also relevant to note that this important matter has now been taken up in the Income Tax (Amendment) Ordinance, 2018, especially with reference to foreign assets, and the Ordinance has been amended the existing provisions of the Income Tax Ordinance, 2001 as a part of overall scheme for the declaration of foreign assets introduced on April 8, 2018. This subject has direct and to the point effect on the one-time compliance scheme as announced by the Government of Pakistan through the Foreign Assets (Declaration & Repatriation) Act, 2018.
What is the concept of time limitations under the taxation laws?
All the taxation laws are essentially divided into two parts. One part relates to the manner and process of taxation of income declared in the return of income filed by the taxpayer. The second part relates to the manner and process of taxing income that is concealed or not declared in the return of income. The second part is always the core of taxation laws. There has to be a mechanism for identifying concealed income and assets created out of concealed income and the time limitation, if any, prescribed for undertaking such actions.
Income whenever concealed is transformed into assets or unexplained expenditure. This means that whenever there will be concealed income, there will be concealed assets or unexplained expenditure the sources of which are not disclosed to authorities. The question under consideration is the time limitation within which such income can be taxed.
All income tax laws relate to taxation of income. There is no general concept of taxation of assets. Wealth tax and other such taxes which were there in the past have gradually been abolished throughout the world. If income is properly and adequately taxed then there is no point in double taxation of assets created out of such income.
The question in every jurisdiction is whether there should be a 'time limitation' for the period within which an income can be taxed. Concealed income when converted into asset, is located on the identification of asset. Once an asset is located, the second question under the income tax law is to tax the income in the year in which such income has been earned. In all practical sense, whenever there is a concept of taxation of income, the asset identification would have to relate back to the year in which the income was earned. It has no direct nexus with the year in which it is discovered. This is the universal concept of taxation of income. The second question is whether the legislature can provide unlimited and untainted right to tax income of any past year. In that sense, even the income for the year 1922 can be taxed. Accordingly, there is unanimous view in all legislations that there should be a time limit to tax the income. It may be five years or 10 years, as the case may be. In general, the period of five years is considered as appropriate time for 'reopening' a case for taxing an income. This accordingly means that if some income remains undisclosed for five years and tax authorities are not able to open the case for that person during that year then after the expiry of such period such income cannot be taxed under the Income Tax Ordinance, 2001. This was the position in the Income Tax Ordinance, 1979, the Income Tax Act, 1922 and the Indian and the English taxation laws with some variation in period of time limitations. This would naturally mean that when an income cannot be taxed after the expiry of five years then assets created out of such income and unexplained expenditure incurred in that period also falls outside the ambit of taxation.
Illustration
Mr A is a resident taxpayer. An asset is discovered in the year 2016 in the name of Mr A that has not been disclosed in the wealth statement filed by Mr A.
The tax officer has the right to ask Mr A the sources from which such asset has been created. In case, if tax officer can prove that such asset was created in 2012 and the income of such year was concealed by Mr A then an amount equal to the value of asset will be treated as concealed income and tax in the year 2012 by reopening the assessment of Mr A for the year 2012.
If the tax officer identifies that such asset was created in the year 2000 then such amount cannot be taxed in the hands of Mr A for the reason that for taxing such income, assessment for the tax year 2000 will have to be reopened and that cannot be done.
The process of taxing concealed income
This means that following process is to be undertaken for taxing the undisclosed or concealed income:
(i) Identification of the concealed asset;
(ii) requiring the owner to explain the source of income from which such asset has been created;
(iii) identifying the tax year in which such income has arisen; and
(iv) reopening or assessing the income in the year when such income has arisen.
In case if it is identified that tax year is barred by limitation then such assets cannot be taxed primarily for the reason that law relates to taxation of income not assets.
Status in the Income Tax Ordinance, 2001
This aspect is always expressly stated in every taxation law. In our Income Tax Ordinance, 2001 this aspect has been covered in Section 111(2) of the Ordinance.
Prior to the amendment made by the Income Tax (Amendment) Ordinance, 2018 the law stated as under:
"(2) The amount referred to in sub-section (1) shall be included in the person's income chargeable to tax in the tax year to which such amount relates."
This provision means that if any undisclosed asset or unexplained expenditure is identified in the year 2018 then same can be taxed only if it has been proved that such asset has been created out of undisclosed income after 2012. If it can be proved that such asset has been acquired out of income that has not been taxed, say in 2000, then the same cannot be taxed in 2018. This is termed as concept of taxing with reference to 'year of acquisition'.
In the composite package in relation to undisclosed foreign assets, one major amendment has been made in the income tax law is the change in section referred above. This change can create a major handicap to curb the tendency of non-declaration of assets outside Pakistan by Pakistani citizens.
Section 111(2) has been amended by the Income Tax (Amendment) Ordinance, 2018 and the new sub-section (2) of Section 111 of the Income Tax Ordinance, 2001 states as under:
"(2) The amount referred to in sub-section (1) shall be included in the person's income chargeable to tax-
(a) in the tax year to which such amount relates if the amount representing investment, money, valuable article or expenditure is situated or incurred in Pakistan or concealed income is Pakistan-source; and
(b) in the tax year immediately preceding the tax year in which the investment, money valuable article or expenditure is discovered by the Commissioner and is situated or incurred outside Pakistan and concealed income is foreign-source;"
As a student of tax, it is author's view that this is the most important change that has been made in the taxation law of Pakistan in the past 70 years. The concept of 'time limitation' absolutely been removed with respect to foreign assets and foreign source income.
This means that under the amended laws, whenever a foreign asset or foreign income is 'discovered', the same can be taxed in the tax year preceding the year of discovery irrespective of the time when such asset was acquired and general time limit has expired.
If we analyze the definition further, it is revealed that under the present wording, the concept of year of discovery is limited to 'foreign source income' only even if the asset is located or situated outside Pakistan. This means that undisclosed foreign assets can be taxed in Pakistan under this concept only if:
(a) they are created out of foreign source income; and
(b) the source is unidentified.
As such, the undisclosed foreign assets are not taxable if created out of Pakistan source income and are explainable.
This further means that concept of year of acquisition with respect to assets created out of Pakistan source income has rightly not been disturbed in any sense. Nevertheless, the same has been completely changed for other cases.
Illustration A:
The amended law can be explained in relation to illustration referred above.
In this illustration, if it is assumed that Mr A has two sources of income. First is the foreign source, say being the income which he may have earned from a deposit held outside Pakistan say the UK. Second is the Pakistan source income which he has earned in Pakistan. Under the amended law, the concept of reopening in relation to 'foreign income and asset created out of such income will apply in relation to year preceding the tax year in which such asset is 'discovered'. It means that in this case, it will be 'deemed' that income relates to year preceding the tax year of discovery. Time limitation will not apply for foreign source income if located outside Pakistan.
Illustration B:
In the same case, if the foreign source income is, say, from salary from an employment in the Middle East that has been transformed into real estate in the UAE, the problem is slightly complicated for the reason that income though being there for Mr A is not chargeable to tax in Pakistan. Even if the amended law is applied, the question of taxability does not arise for the reason that sum was not chargeable to tax being foreign source when Mr A was a non-resident. Only other question is disclosure in wealth statement.
Now within illustration B, two sub-cases will emerge. One will be those who are able to identify the sources in the Middle East that were not taxable in Pakistan. For them a positive position with respect to declaration can be adopted, however, they would have to explain and identify before the tax officer in Pakistan, the nature of income, the non-chargeability in Pakistan and other aspects. Other are those cases where such explanation is not applicable. For them positive assertion cannot be adopted. Their option is availing one time compliance scheme.
Illustration C:
There can be another situation. In case, if in any future year there is a discovery of a foreign asset, say a flat in the UAE or London in the name of Mr A. However, if it is proved by Mr A that such asset has been created out of Pakistan source income then time limitation will apply in relation to year of acquisition not the year of discovery.
Relationship with one-time compliance scheme
Federal government has announced one-time compliance scheme for undeclared foreign assets and income. Persons having such assets are necessarily required to conjunctively examine the aforesaid change in the manner and scope of taxation of foreign source or unidentified source of income for the reason that on account of this change in the regime, which is fundamental in character, the excuse of time limitation is no more available and applicable.
In case, if an opportunity and a window has been provided by way of 'one-time compliance scheme' then that should be availed otherwise the forthcoming regime on this subject is strict and charges for default are severe.
Conclusion
The process that started with the revelation of the 'Panama Leaks' is now reaching its conclusion by way of appropriate changes in laws and procedures. The change in the concept of time limitation is a major and appropriate step to bring foreign assets held by Pakistani citizens within documentation. In the overall context of international scenario of tax compliance that is emerging around the world, it would be advisable to declare the undisclosed assets appropriately as steps are being undertaken to curb the tendencies and avenues that lead to non-declaration. It is suggested to the people owning undisclosed assets to avail the declaration proposition as in future, stringent provisions will be applicable.